Real Estate (REIT) ETFs

by: SA Editors

What Are They?

  • Real Estate Investment Trusts, knows as "REITs", are publicly traded companies that purchase and manage income generating properties such as offices, apartments or shopping malls (equity REITs) or mortgage loans (mortgage REITs).
  • US REITs are classified for tax purposes as pass-through entities, meaning that they are free from tax at the corporate level. To be classified as a REIT, a real estate company must pay out at least 90% of its taxable income to its shareholders in the form of dividends. Individuals are then taxed on those dividends as normal income, not at the lower rate for stock dividends. (Check this with your accountant.)
  • REIT ETFs are tradeable index funds that hold REIT stocks. Because REITs must pay out at least 90% of their taxable income as dividends, REIT ETFs tend to generate higher dividend yields than other ETFs and are often classified as "dividend paying ETFs".

Why & How To Use Them

  • REITs are a distinct asset class to stocks and bonds, and offer exposure to real estate without the hassle of directly owning and managing property. REIT ETFs therefore provide added diversification to a portofolio.
  • REIT ETFs can also be used to hedge exposure to the real estate market. Individuals who want to purchase property in the future can try to hedge against price rises by purchasing REIT ETFs, and individuals planning to sell property in the future can try to hedge against price declines by selling short REIT ETFs.
  • Residential REIT ETFs are also a tool for speculation on house prices. Some people who believe the housing market is in a bubble have advocated selling short residential REIT ETFs.

What to Look Out For

  • Some people think that REIT ETFs can be used to hedge property prices. But REITs own portfolios of properties that may differ significantly from property owned by individuals, so trying to hedge your house price by shorting a residential REIT ETF may fail. And homebuilder ETFs may be better correlated to house prices.
  • Because REITs pay hefty dividends, shorting REIT ETFs may be expensive, as the short seller is obligated to pay the dividends.
  • The broad REIT indexes tend to be dominated by commercial real estate REITs, such as those owning offices and malls.

Further Reading

This page is part of The Seeking Alpha ETF Selector which sorts ETFs by type, highlights how to use them and what to look out for, and provides links to articles that discuss key issues for investors.